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Before the credit crisis, David Matlin was one of the most revered distressed investors on Wall Street, but his $1 billion investment in a Michigan thrift continues to look like a disaster. The Department of Justice announced late on Friday afternoon that Flagstar Bancorp had agreed to pay $132.8 million to settle a new government civil lawsuit that claimed the bank improperly approved residential home mortgage loans for government insurance.

As part of the deal, Flagstar admitted that it had submitted false certifications to the Department of Housing and Urban Development, inducing the Federal Housing Administration to accept loans for government insurance that were not eligible and that resulted in losses to HUD when the loans defaulted.

In a statement, Flagstar said it will have an increase in net losses of between $25.9 million and $34.3 million for the fourth quarter of 2011. The company expects to tell investors “in the near future” about the financial impact the settlement with have as of December 31, 2011.

Flagstar’s settlement with federal prosecutors in Manhattan is the latest setback for Matlin and his private equity firm, MatlinPatterson Global Advisors. The humbling experience was the subject of a Forbes story in October.

Matlin got his firm in late 2008 to inject $250 million in the moneylosing Flagstar, a $14.2 billion thrift that specialized in originating prime residential home loans. As the credit crisis raged, Matlin acquired 70% of the bank’s beaten-up shares, an investment that was conditional on the bank getting $267 million of bailout TARP funds from the government.

But Matlin drastically underestimated the extent of the nation’s housing slump and continued to bet more money on struggling Flagstar until his investment stood at $1 billion. That investment was worth $267 million after the market closed on Friday prior to news of the settlement and is likely to head lower on Monday. The Flagstar deal increasingly looks like one of the worst private equity deals that tried to profit off the troubles in the financial sector. Some of those deals, like OneWest Bank and BankUnited, have been home runs. But other deals have tanked. David Bonderman got his private equity firm, TPG, and other investors to put $7 billion behind ailing S&L Washington Mutual just before the government seized it, wiping out TPG’s $1.35 billion contribution.

“The lawsuit filed today is another stark example of how certain lenders put profit ahead of responsibility by recklessly churning out mortgage loans without regard to the risk that those loans would default or the significant consequences for the individual homeowners who would inevitably default on their loans, the housing market, and in the aggregate, our nation’s economy," Preet Bharara, the U.S. Attorney in Manhattan, said in a statement. "Participation in this federally subsidized program is a privilege, not a right, and the cases this office has filed against banks that abuse this privilege should underscore our commitment to holding them to account."